MICHAEL KEATING. Trickle-Down Economics and a Company Tax Cut

Jan 18, 2018

Despite the evidence of the last few decades that ‘trickle-down’ economics doesn’t work, big business and its apologists in the media are calling for a company tax cut to stimulate investment. The reality, however, is that increased investment is principally in response to increasing aggregate demand. The required increase in aggregate demand in turn requires less inequality and faster wage growth, not bigger business subsidies.  

The two outstanding facts regarding the developed economies in the 21st century are:

  1. Economic growth has been very sluggish over almost two decades, and since the global financial crisis economic growth in the advanced member countries of the OECD has averaged less than half the annual rate of the previous quarter century
  2. Income inequality has risen in almost all the developed economies for the last 30 years or more.

In our forthcoming book, Fair Share, which will be released at the beginning of March, Stephen Bell and I show why these two central facts are connected. Nevertheless, big business and its spokesmen in the Business Council and media organisations, like the Australian and the Australian Financial Review, are busy trying to persuade us that a company tax cut is the solution to slow growth, and that the benefits will trickle down.

The argument by these apologists for self-interest is that a company tax cut will increase the incentive to invest, leading to an increase in investment, which will create more jobs, and that will eventually trickle down into higher wages. Put simply, they are asking us to believe that we all win from a tax cut for the rich, and we shouldn’t worry if some win by more than others and if those who are most disadvantaged must wait longer as well.

In a forthcoming article (based on our book), Stephen Bell and I show that at some times in the past, some economies have been “profit-led”, but the more common experience has been that an economy’s aggregate demand is “wage-led”. ‘Whether an economy is wage or profit-led, depends on structural fundamentals in a given economy: comprised mainly of the relative contribution of key sources of aggregate demand (consumption, investment and net exports), as shaped by structural economic factors including labour market dynamics, the distribution of income, the propensity to consume or invest, and the relative size and sensitivity of exports to costs, such as wage costs’ (Bell & Keating, forthcoming). We argue that these structural economic factors can change over time, perhaps flipping a given economy from being wage-led to profit-led and back again. In recent times, however, the economies of most OECD member countries, including Australia, have been wage-led, and in these circumstances, any further shift in the income distribution towards greater inequality can only further impede economic growth.

Furthermore, our findings are independently supported by the two most significant international organisations engaged in macroeconomic policy, with the IMF (2015: 7) finding that:

If the income share of the top 20 per cent increases by 1 percentage point, GDP growth is actually 0.08 percentage points lower in the following five years, suggesting that the benefits do not trickle down (my emphasis). Instead, a similar increase in the income share of the bottom 20 per cent (the poor) is associated with 0.38-percentage-point higher growth.

While, the OECD (2014: 2) has similarly found that, ‘Raising inequality by 3 Gini points, that is the average increase recorded in the OECD over the past two decades, would drag down economic growth by 0.35 percentage points per year for 25 years: a cumulated loss in GDP at the end of the period of 8.5 per cent’. As the IMF (2015: 4) concludes, ‘income inequality matters for growth and its sustainability’.

Right now, the reality is that profit rates have never been higher in most developed countries, but investment has been lagging. Increasing the rate of return through company tax cuts is not going to increase investment so long as aggregate demand stays depressed. Instead, the evidence is that the huge increase in profits during this century has been largely returned to shareholders through increased dividends and buybacks of shares. The most extreme example is probably the US where the ratio of these payouts to shareholders from profits has more than doubled over the course of this century. But this increasing failure to use rising profits to create new assets is a common phenomenon.

Two former governors of the US Federal Reserve Bank, Ben Bernanke and Alan Greenspan have each attributed this lack of investment in new assets to a shortage of good investment opportunities, and this shortage is likely to continue so long as aggregate demand remains depressed. In addition, a further explanation for the increase in pay-outs to shareholders is that the remuneration of managers is tied to the share price and managers therefore have a vested interest in increasing asset prices rather than in increasing the amount invested in new capacity. Furthermore, these managers, and shareholders more generally who benefit from higher pay-out ratios, are mostly in the top income groups, so this shift to profits is one of the factors leading to higher inequality and depressed aggregate demand.

In any event, aggregate demand will stay depressed so long as wage growth is depressed, and therefore so will business investment. Indeed, the situation has got worse since the Global Financial Crisis (GFC). Prior to the GFC, many countries were able to escape the low-growth trap caused by lower wages, by increasing household debt, or by increasing their exports and thus exporting their ‘excess savings’. However, exporting your way out of stagnant demand is not a sustainable solution to inadequate demand, as it is only available to some countries, and comes at the expense of others. Similarly, increasing consumer debt is equally non-sustainable, and in fact ceased in many countries following the GFC.

As the Governor of our own Reserve Bank, Philip Lowe (2017) recently commented: ‘The crisis really is in real wage growth’. Pleas for company tax cuts by big business and their media lackeys, on the grounds that the benefits will trickle down, are the height of self-interested hypocrisy. They are not supported by any evidence, not by any authorative commenters who have explored that evidence.


Bell, S. & Keating, M., 2018, Fair Share: Competing Claims and Australia’s Economic Future, Melbourne University Press, Melbourne. This book is expected to be available in bookshops from 1 March next.

Bell, S. & Keating, M., 2018 forthcoming, The Limits of Neoliberalism and the New Demand-Side Imperatives: A Distributional Theory of Sustainable Economic Growth in Capitalist Economies.

IMF 2015, ‘World Economic Outlook: Adjusting to Lower Commodity Prices’, World

Economic Outlook, International Monetary Fund Publication Services, Washington,


Lowe, P., 2017, ‘Remarks at Reserve Bank Board Dinner’, Melbourne, 4 April.

OECD, 2014, Focus on Top Incomes and Taxation in OECD Countries: Was the crisis a game changer? OECD Publishing, Paris.

Michael Keating, AC, is a former Head of the Departments of Employment and Industrial Relations (1983 -86), Finance (1986-91), and Prime Minister and Cabinet (1991-96).


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